Bears abandon ship as US job growth returns but infection rates must be watched as lockdowns ease
Does anything matter to stock markets?
The rally in US stocks continued last week as bears are now throwing the towel in droves. The unexpected surge in the May payroll numbers, a reflection of quicker end to lockdowns killed the validity of any remaining short term bearish scenarios, arguing that stocks have run way ahead of fundamentals and it could be time for at least some consolidation. Not only stocks have surged ahead during the time of high fatality rates from Covid infections and at a time of complete lockdown that had put any economic activity at pause, but buyers have also shrugged off growing geopolitical tensions with China and most recently, mass protests and social unrest across the US in the wake of Mr. George Floyd’s death in the hands of Minneapolis police. In the eyes of stock market participants, it seems nothing can derail the rebound that has pushed S&P to just 5% below its all time highs of mid-Feb while Nasdaq is now at its highs posted at the time.
With record $4.7trn of funds parked in US money markets and cash as percentage of equity market capitalisation having reportedly zoomed to 16% from 10% before the pandemic was declared, we have argued that the weight of cash is too high to expect any notable correction in stocks and institutional investors are simply too underweight to sit on the sidelines for long. With the latest payroll data suggesting that re-hirings have begun a month earlier than many had been expecting, especially within the hardest hit service sectors, and with treasury market under renewed selling pressure, we see no other option for institutional money but to raise their weighting in equities in the near term.
Our own stock market strategy in Japan had also evolved from last month, from being massively overweight in technology names which we had for months argued is more of a defensive stance that generated very decent alpha, to suggest buying the great outdoor plays while also recommending investors to participate in the emerging ‘dash for trash’ trend which had investors starting to accumulate more bombed out cyclical/industrial value names. Last month, we had also removed the last of our shrinking list of cyclicals from our short sell picks, replacing them more with names within more traditional defensive segments as well as stay-at-home beneficiaries like video games stocks which we think should also under-perform as lock-down regimes ease. So far so, so good!
Yes, politics matters!
In the last few weeks we have also argued that despite louder drum beats of China bashing, prospect of a trade war between US and China seems unlikely as domestic issues have increasingly become the focal point for US voters amid high unemployment and the growing number of medically uninsured which have also raised anxieties in the middle of a pandemic. Recent protests across the country demanding social justice have only added more pressure on the Trump Administration to concentrate more on domestic issues ahead of the US presidential election and the blame game is no longer looking as effective.
Moreover, China had reportedly halted “some” of its US agricultural purchases last week, likely as a warning to the US president that Beijing could once again leave US farmers facing economic hardship, testing the resolve of one key segment of his support base which had already suffered from last year’s suspension of Chinese purchases. Indeed, the US trade representative, Robert Lighthizer pointed out last Thursday that he feels “very good” about the phase one trade agreement with China, which is “honouring” the pact despite the COVID-19 pandemic and denied that China is halting its purchases. In our view, China’s message has been clearly received and understood and Trump knows that he can ill-afford to enter a trade war and alienate yet another of his support groups.
Indeed, we think the US president who seemed elated by the latest job numbers, evident by his numerous tweets of congratulating himself, will now be more determined to push through additional fiscal stimulus to try to raise his chances for a re-election in November. Although the oversupply of treasury bonds from surging issuance is something that economist are starting to worry about as prospects of higher long term rates seem increasingly unavoidable, in the short term, any measures to boost public infrastructure spending, to help US states retain employment of their public servants as well as a pay-roll tax cuts, will all likely to be further celebrated by the US stock market over the next few weeks.
Meanwhile, the spread of the virus continues to rage on
Although we think the chances of seeing another lockdown in the future is highly unlikely, regardless of what happens, global daily fatalities rates from Covid-19 infections remain at record levels just as countries begin easing their isolation regimes. Although we have long argued that the pathogen is now in our echo system and is unlikely to be eradicated until we develop an effective vaccine, we are keeping a very close eye on the resurgence in hospitalisation rates as we think easing of lockdowns should depend on medical systems’ capacities being able to cope and we don’t see this condition has been met in many countries. We suspect infections rates are likely to rise once again to more alarming levels by the end of June, especially in the US (which what matters for markets) given mass protests and lax regimes in the mid-west.
We are also watching the dire situation in Brazil very carefully as death rates there are mounting while the country enters its winter months of a country in the southern hemisphere. This observation could provide vital clues if falling temperatures will indeed usher in another big wave of infections in the fall in developed nations as it did in the 1918 pandemic. If our fears transpire, the month of July could prove challenging for stock markets which by then should have priced in a more v-shaped economic recovery which will ultimately be determined by consumer behaviour and depend on people becoming less fearful of catching the virus. So although going back to mass lock-downs seem politically and economically untenable, cautious spending patterns could lead to an eventual reality check that global economic activity will remain at sub-optimal rates which could negatively impact the stock market before autumn.